A central issue in macroeconomic policy analysis is the need to take account of the likely changes in people’s expectations about the future resulting from the adoption of one policy or another, not only what they expect is most likely to happen but also the degree of certainty that they attach to that expectation. This is a key issue because expectations are a crucial determinant of rational behavior. A macroeconomic model founded on individual optimization should allow, in particular, for consideration of the desirable response of monetary policy to asset price “bubbles” inconsistent with “rational expectations.” This approach dispenses with the idea that expectations can be uniquely predicted and instead requires policy to be robust to any expectations within certain bounds.
This research project develops an approach to policy analysis in the context of a macroeconomic model that does not assume that people in the economy forecast the economy’s future evolution under any given policy in the same way as the policy analyst’s own model does.
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